The Basics of Economic Growth
The Basics of Economic Growth
• The economic growth rate is the annual percentage change of real GDP.
• The standard of living depends on real GDP per person, which is real GDP
divided by the population.
• Sustained growth of real GDP per person can transform a poor society into a
• We calculate how many years it takes for the level of any variable, including real
GDP per person, to double, by using theule of 70.
• The Rule of 70 states that the number of years it takes for the level of any
variable to double is approximately 70 divided by the annual percentage growth
rate of the variable.
Long-Term Growth Trends
• Long-term growth trends are the trends in potential GDP.
• Check out Figure 22.2 on p. 518 of your textbook to study real GDP per person
in Canada between 1926 and 2007.
• During this period, real GDP per person grew 2.1 percent a year, on the average.
• Real GDP growth has been similar in Canada, the Europe Big 4 (France,
Germany, Italy, and the United Kingdom), and the United States since 1960.
Growth in Japan was very rapid during the 1960s, slower during the 1980s, and
even slower during the 1990s.
Changes in Potential GDP
• Potential GDP increases if there is an increase in population or an increase in
• An increase in population increases the supply of labour.
• In the figure, the labour supply curve shifts rightward fromo LS , the real
wage decreases and the quantity of labour employed at full employment
increases. • In the figure below, the increase in the full-employment level of labour increases
potential GDP from $1,000 billion to $1,300 billion along the production function.
• With an increase in population, potential GDP per hour of work decreases.
• Initially, with potential GDP at $1,000 billion and labour hours at 20 billion,
potential GDP per hour of work was $50.
• With the increase in population, potential GDP is $1,300 billion and labour hours
are 30 billion, and potential GDP per hour of work is $43.33.
• Diminishing returns are the source of the decrease in potential GDP per hour of
work. • Labour productivity is the quantity of real GDP produced by an hour of labour,
calculated by dividing real GDP by aggregate labour hours.
• Labour productivity increases if there is:
o An increase in physical capital
o An increase in human capital
o An advance in technology
• In the figure below, an increase in labour productivity increases the demand for
labour, and the demand for labour curve shifts rightward from LD to LD .
• The real wage rate rises from $35 an hour to $45 an hour and the full
employment quantity of labour increases from 20 billion hours to 22.5 billion
• The production function shifts upward and potential GDP increases from $1,000
billion to $1,500 billion. Potential GDP per hour of work also increases from $50
to $66.67. • The purpose of growth accounting is to calculate how much real GDP growth
results from growth of labour and capital and how much is attributable to